A favorable variance means that the actual hours worked were less than the budgeted hours, resulting in the application of the standard overhead rate across fewer hours, resulting in less expense incurred. However, a favorable variance does not necessarily mean that a company has incurred less actual overhead, it simply means that there was an improvement in the allocation base that was used to apply overhead.

The variable overhead efficiency variance is a compilation of production expense information submitted by the production department and the projected labor hours to be worked, as estimated by the industrial engineering and production scheduling staffs, based on historical and projected efficiency and equipment capacity levels. It is entirely possible that an improperly-set standard number of labor hours can result in a variance that does not represent the actual performance of an entity. Consequently, investigation of the variable overhead efficiency variance should encompass a review of the validity of the underlying standard.

Variable Overhead Efficiency Variance Example

The cost accounting staff of Hodgson Industrial Design calculates, based on historical and projected labor patterns, that the company's production staff should work 20,000 hours per month and incur $400,000 of variable overhead costs per month, so it establishes a variable overhead rate of $20 per hour. In May, Hodgson installs a new materials handling system that significantly improves production efficiency and drops the hours worked during the month to 19,000. The variable overhead efficiency variance is: